Saturday, March 30, 2013

The “knowledge problem” according to Hayek consists in explaining how a market economy overcomes the problem of dispersed, decentralised knowledge of supply and demand and the many individual plans and preferences of both consumers and producers. His classic article on the subject was published in 1945 in the American Economic Review (35.4 [1945]: 519–530).

But, curiously, various Austrians – mainly Misesians and Rothbardians – are unsatisfied with Hayek’s paper. Even Kirzner complains that in the “Use of Knowledge in Society” Hayek made “it appear that the function of prices in communicating knowledge was a function that is filled, in principle, also in the state of equilibrium” (Kirzner 2000: 157).

Salerno argues that Hayek’s “knowledge problem” is different from Mises’s “socialist economic calculation” problem, and even Kirzner concedes that Mises did not formulate the “calculation problem” in terms of knowledge (Kirzner 2000: 158).

What is Hayek’s argument?

The economic data for a whole society are never given to a single mind (Hayek 1945: 519) or given to any person “in its totality” (Hayek 1945: 520). A rational economic order is characterised by a state of affairs in which the relevant information exists “solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess” (Hayek 1945: 519). Planning is obviously done by very many individuals in a decentralised manner (Hayek 1945: 521).

Therefore the “various ways in which the knowledge on which people base their plans is communicated to them is the crucial problem for any theory explaining the economic process” (Hayek 1945: 520). At the same time, specific knowledge of “particular circumstances of time and place” is also very important (Hayek 1945: 521): that is, the knowledge that individual business people have of their markets, stocks, trades and capital goods, and so on.

In dealing with economic change, the best people to make the decisions are those who know their businesses, resources and markets: the “man on the spot,” as it were (Hayek 1945: 524).

Yet business people need to fit their decisions into the “whole pattern of changes of the larger economic system” (Hayek 1945: 525).

For Hayek, the price system communicates this knowledge (Hayek 1945: 526). As an example, Hayek thinks of an increase in demand for tin. The price of tin rises: buyers of tin now know they must economise tin.

What are the problems with Hayek’s theory?

We can set the problems out below:

(1) the implied assumption of Hayek’s argument (so his Misesian critics argue, perhaps not unfairly) is an economy near equilibrium, or (that is to say) in a “proximal equilibrium” state.

(2) the failure of Hayek to understand the role of Knightian uncertainty;

(3) the role of fixprice markets and administered prices, and

(4) the destabilising role of speculation in prices.

First, the role of “proximal equilibrium.” Hayek briefly nods his head at the reality that price adjustments in the real world are never “perfect” as in equilibrium analysis (Hayek 1945: 527), but his actual theory does require reasonably flexible – if not perfect – price adjustments in all markets. It is no surprise that even Austrian critics of Hayek complained that his theory treats the world as if it is in a state of “proximal equilibrium.”

Salerno contends that:

“as Hayek points out, in order for prices to fulfill their knowledge-disseminating and plan-coordinating functions, the economy must subsist in a state of what I will call ‘proximal equilibrium,’ wherein realized prices are always fairly accurate indicators of future prices.” (Salerno 1993: 128; cf. Horwitz 2004: 314–315).

“Uncertainty for Hayek means that each individual decision maker only has a small piece of the puzzle. However, as a whole, the aggregated set of all decision makers have a complete set of all relevant knowledge. There are no pieces missing, lacking or unavailable from the puzzle. Market prices organize and synthesize the aggregate amount of knowledge so that market price signals, understood only by savvy, knowledgeable entrepreneurs, [eliminate] … any uncertainty.” (Brady 2011: 14).

“Keynes, Knight and Schumpeter deny Hayek’s claim that the market generates price vectors which concentrate the knowledge so that savvy, knowledgeable entrepreneurs can act on this information and solve the problem of uncertainty. Uncertainty means vital important information is missing. Pieces from the puzzle are missing and will not turn up in the future” (Brady 2011: 14).

“Hayek could not accept the standard concept of uncertainty as defined by Keynes, Knight and Schumpeter because it would then be impossible for market prices to concentrate knowledge that did not exist. In conclusion, nowhere in any of Hayek’s three articles on Knowledge in Economics in 1937, 1945 and 1947 does Hayek deal with the standard view that uncertainty means knowledge that is not there.” (Brady 2011: 15).

Prices that remain essentially rigid in response to demand changes (quite frequent in the real world) cannot have the knowledge-communicating role of Hayek’s theory.

And finally Hayek’s theory never considers the destabilising role of commodity speculation. How can relevant information be communicated if prices are distorted by speculative activity, and therefore are not related to underlying supply and demand?

Finally, there is one statement in the paper that Hayek never develops:

“We must look at the price system as such a mechanism for communicating information if we want to understand its real function—a function which, of course, it fulfils less perfectly as prices grow more rigid. (Even when quoted prices have become quite rigid, however, the forces which would operate through changes in price still operate to a considerable extent through changes in the other terms of the contract.)” (Hayek 1945: 526).

It never occurs to Hayek that, in the advanced capitalist economies of his day, prices had already grown rigid in many markets because of administered prices. Yet economic coordination continued to occur, and economic growth and markets continued to function, and after 1945 far better than in previous periods.

And what other forms of the business contract allow economic coordination without flexible prices? Hayek never tells us, but in reality it is “quantity signals” that are the fundamental factor in fixprice markets that equate supply and demand, but Hayek never understood that.

In short, Pettis points out the similarity of the Chinese growth model to that of America in the 18th and 19th centuries: the protectionist and interventionist model of Alexander Hamilton, Friedrich List, Henry Clay, Henry and Matthew Cary, and John Calhoun, what was at that time called the “American System.” It emphasised:

(1) infant industry protectionism and tariffs;

(2) internal development or what we now call public infrastructure, often through government investment, and

(3) a modern financial system.

I would depart from Pettis on point (3), in the sense that the US banking system in the 19th century was much more unstable and crisis-prone than other systems, and its more laissez faire nature imposed significant costs such as a bias towards debt deflationary dynamics in the 1870s and 1890s.

The astute Japanese followed the successful model of state-led growth pioneered by the US (and to some extent late-19th-century Germany and other nations). That model was refined and developed after 1945 by Japan, South Korea, and Taiwan in the import-substitution industrialization (ISI) model, and now in a new form it has been continued by China.

Nor is China proof of the success of the orthodox policies of globalisation, because China simply did not, and does not, follow those orthodox policies. How can a country with capital controls, state-owned banks, a pegged, undervalued currency (as a mercantilist policy to boost exports), a large state-owned industrial sector, subsidies to key domestic industries, huge non-tariff barriers, and an activist industrial policy be an example of the success of globalisation? Nobody doubts that liberalised foreign direct investment and international trade have been major factors in the success of China, but one cannot look at these policies in isolation. One only needs to look at the use of industrial policy in China as noted, for example, by Clyde Prestowitz many years ago in some insightful work.

In general, a crucial difference between East Asian nations and the US is that East Asia turned towards export-led growth (outward-oriented ISI) as a fundamental driver of development. The downside is that this often leads to not enough domestic consumption and social services.

As far as I can see the United States pursued more balanced development, because by the late 19th and early 20th centuries it had turned away from the export-led growth model to much greater reliance on internal markets and domestic demand.

More seriously, in this interesting paper and in this post, Murphy admits that Sraffa demonstrated that outside of equilibrium there is no single Wicksellian natural rate of interest, and that Hayek never really addressed this problem for his trade cycle theory.

On the face of it, these admissions have devastating consequences for virtually all modern formulations of the Austrian business cycle theory (ABCT) using the unique natural rate, as admitted by Murphy himself:

“In his brief remarks, Hayek certainly did not fully reconcile his analysis of the trade cycle with the possibility of multiple own-rates of interest. Moreover, Hayek never did so later in his career. His Pure Theory of Capital (1975 [1941]) explicitly avoided monetary complications, and he never returned to the matter. Unfortunately, Hayek’s successors have made no progress on this issue, and in fact, have muddled the discussion. As I will show in the case of Ludwig Lachmann—the most prolific Austrian writer on the Sraffa-Hayek dispute over own-rates of interest—modern Austrians not only have failed to resolve the problem raised by Sraffa, but in fact no longer even recognize it.

Austrian expositions of their trade cycle theory never incorporated the points raised during the Sraffa-Hayek debate. Despite several editions, Mises’ magnum opus (1998 [1949]) continued to talk of “the” originary rate of interest, corresponding to the uniform premium placed on present versus future goods. The other definitive Austrian treatise, Murray Rothbard’s (2004 [1962]) Man, Economy, and State, also treats the possibility of different commodity rates of interest as a disequilibrium phenomenon that would be eliminated through entrepreneurship. To my knowledge, the only Austrian to specifically elaborate on Hayekian cycle theory vis-à-vis Sraffa’s challenge is Ludwig Lachmann.”
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 11–12).

“Lachmann’s demonstration—that once we pick a numéraire, entrepreneurship will tend to ensure that the rate of return must be equal no matter the commodity in which we invest—does not establish what Lachmann thinks it does. The rate of return (in intertemporal equilibrium) on all commodities must indeed be equal once we define a numéraire, but there is no reason to suppose that those rates will be equal regardless of the numéraire. As such, there is still no way to examine a barter economy, even one in intertemporal equilibrium, and point to “the” real rate of interest.”
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 14).

If Mosler debates Murphy, he should press him repeatedly on both points.

First, Mosler should point out that Murphy agrees with Keynes on the nature of the interest rate. So does Murphy admit that Keynesians are right in their interest rate theory?

The instant Murphy attempts to explain recessions in terms of the Austrian business cycle theory (ABCT), Mosler should demand to know what version of the ABCT Murphy is using.

Some other points:

(1) Murphy and other Austrians do not properly understand the price system in real world capitalism. They do not understand and (often) do not even acknowledge the reality of extensive fixprice markets and price administration. Many businesses do not adjust prices in reaction to demand changes, but supply: that is, they adjust output and employment. That is a strong confirmation of Keynesian theory.

The Austrian idea that economic coordination in market economies fundamentally requires universally flexible prices determined by the dynamics of supply and demand curves is wrong: economic coordination – to the extent that it does exist – can be created by “quantity signals,” as Nicholas Kaldor long ago understood.

(2) Many Austrians still adhere to an unrealistic market tendency to equilibrium states. But that is an unconvincing view of markets. Austrians do not take seriously their own ideas of (1) subjective expectations and (2) Knightian or fundamental uncertainty.

(3) There is no equilibrium (or market-clearing) interest rate that equates savings and investment. This is just another unsupportable equilibrium idea. If investment depends very much on business expectations, it does not matter how low interest rates are, if business expectations are shocked.

(4) Moreover, we live in an endogenous money world, and although credit does play a fundamental role in driving business cycles, the Austrians have never understood the real problem: credit flows to destabilising asset price speculators.

If Austrians really understood this, their business cycle theory would be concerned with the destabilising role of secondary financial and real asset markets, not with (largely imaginary or overrated) distortions in the capital goods structure of production.

If Say’s Law is defined in some minimal form like “consumption cannot occur without prior production,” then it is a trivially true proposition that is no threat whatsoever to Keynesianism or MMT.

(6) Why are money and secondary financial assets so important for any realistic model of capitalism? The reason is that money and secondary financial assets have a zero or very small elasticity of production. This means that a rise in demand for money or financial assets, and a rising “price” for money (i.e., an increase in its purchasing power) or financial assets will not lead to businesses “producing” money or financial assets by hiring unemployed workers.

Furthermore, the implicit assumption of both neoclassical theory and Austrian economics is the gross substitution axiom: that underlying the operation of all demand curves is the assumption that substitutes for all goods whose prices rise can be found or will emerge, and that even reproducible goods can substitute for non-producible assets and money.

But money and financial assets have zero or near zero elasticity of substitution with producible commodities:

“The elasticity of substitution between all (nonproducible) liquid assets and the producible goods and services of industry is zero. Any increase in demand for liquidity (that is, a demand for nonproducible liquid financial assets to be held as a store of value), and the resulting changes in relative prices between nonproducible liquid assets and the products of industry will not divert this increase in demand for nonproducible liquid assets into a demand for producible goods and/or services” (Davidson 2002: 44).

The gross substitution axiom is a fundamental assumption of neoclassical economics and the Austrians appear to tacitly assume the axiom as well. But the gross substitution axiom is wrong, and all inferences made from it in economic theories are also wrong.

Come to think of it, I could debate Murphy myself, or any Austrian for that matter. I could take most of them down in an hour or so!

This is an interesting talk by Patricia Churchland on ethics, evolution, and the brain.

What was particularly interesting are the comments (from 28.10) on the way in which the evolutionary expansion of the forebrain in mammals and in humans allows greater prediction and anticipation of future events and social problems. That is no doubt a cause of the successful ability of humans to be social and live in groups.

While it is vitally important to understand what science has to say about the evolution of human moral ideas, just because we can identify some innate senses of right and wrong (which humans have evolved through social life in communities during our evolutionary history), it does not mean that we have found an objective theory of morality, one which that can function as a consistent, logical and universal system for justifying our moral choices, both now and in the past. This is in fact committing the appeal to nature fallacy.

The well-known fact that there is a vast chasm between what can be regarded as moral in one society and immoral in another demonstrates that, like our language faculty (which also has a biological basis), our innate moral intuition can lead to quite different systems of morality in different cultures in different times (just as our core language faculty leads to vastly different languages, with different words, grammar and syntax).

In the end, only an objective theory of morality (e.g., Kantian ethics, utilitarianism) can demonstrate that some things are immoral today and also immoral in the past or future. So it turns out the innate sense of right and wrong is not the same thing as an objective theory of morality.

The basic unit of logic and descriptive fact is a statement in the indicative mood – or (1.a) above – what we call the declarative sentence. In logic, this is also called a proposition. The proposition can be true or false. That is, it has truth value.

Next, there is the perplexing problem of whether sentences in the subjunctive mood can be true or false. The truth be told, I have never been able to find a straightforward, satisfactory answer to the question whether a subjunctive can be true or false! Let us leave this question unresolved.

What can be said is that a question, exclamation or command is never true or false, and all such sentences are fundamentally different grammatical categories from propositions.

For example, an imperative – category (2) above – is an order, instruction or command, such as “Go home!,” “Walk the dog!,” “Keep off the grass!” But these commands are not true or false.

One moral theory that has been advanced by philosophers is prescriptivism, a non-cognitivist view of ethics.

According to prescriptivism, the moral statement is really a special kind of command (or imperative). Sentences with the word “ought” (“You ought not steal”) really conceal an imperative, a command.

The revolutionary conclusion of R. M. Hare is that a moral statement is not really a declarative sentence that can carry a truth value (that is, being either true or false). We are mistaken in thinking this. Moral statements are really just commands, and they urge action.

Many moral injunctions are really universalisable imperatives. That is, they invoke types or kinds and are addressed to the world at large, to people in general (Scruton 1994: 275).

And now the crucial point: by admitting that moral injunctions are imperatives and are neither true nor false, the prescriptivist is not abandoning rational thinking about what to do in the sense we normally call moral or ethical.

Actually, we can still have a rational debate about “moral” action! Moral injunctions follow the logic of imperatives (perhaps also inductive arguments about how to achieve teleological ends). It is a mistake to think you can only reason about declarative sentences, because imperatives do not necessarily lack a type of logic of their own. For example, imagine a set of books on a table. Someone says, “Carry all these books to the library!” If one considers any one particular book on the table, the command “take this particular book to the library!” follows from the first imperative (this example is based on the one in Scruton 1994: 275).

For the prescriptivist, the point is that an “ought” statement is never logically entailed by any other descriptive fact or facts. The prescriptivist admits that Hume’s “is–ought” problem is unsolvable, but has successfully evaded it.

At this point, I depart from the strict views of prescriptivists, with other observations. What is the justification for any particular moral injunction? It needs to be rational.

One can construct inductive arguments to the effect that if one wants to achieve certain aims or ends, then certain actions should be followed. The conclusion of an inductive argument is never absolutely certain, and only ever probable. Therefore the fundamental claim of prescriptivism is not violated: no imperative or “ought” statement is strictly logically entailed by any inductive argument made to support it, in the way that the conclusion of a deductive argument logically and necessarily follows from its premises.

That is to say, rational discourse in ethics is in the same category as other forms of knowledge using inductive reasoning.

Prescriptivism does not satisfy many moral philosophers. Serious objections can be made. If what we think of as a moral judgements are not really true or false, it follows that moral error in the normal sense is impossible. At most, one could attack someone as urging action or performing action that lacks rational justification. Is that a satisfactory view of morality?

If I consult the general book I usually turn to when I want guidance on some general issue in philosophy, Roger Scruton’s Modern Philosophy: An Introduction and Survey (1994), I find that Scruton was unimpressed by prescriptivism. Perhaps that opinion is widespread amongst modern analytic philosophers.

Or maybe it is time to take a second look at prescriptivism, and see whether it can be developed in new ways!

APPENDIX
To see where prescriptivism is located in a classification of ethical theories, we can provide a general classification of normative ethical theories here:

Wednesday, March 27, 2013

There is something strange about the moral landscape of a considerable body of people who call themselves libertarians. Many of them are quite conservative Christians. But for the conservative Christian there is an insuperable barrier to the most extreme forms of libertarianism.

Consider these passages from the New Testament:

(1) St Paul, Romans 13.1–7 (written c. 56 AD):
“Let every person be subject to the governing authorities; for there is no authority except from God, and those authorities that exist have been instituted by God. Therefore whoever resists authority resists what God has appointed, and those who resist will incur judgement. For rulers are not a terror to good conduct, but to bad. Do you wish to have no fear of the authority? Then do what is good, and you will receive its approval; for it is God’s servant for your good. But if you do what is wrong, you should be afraid, for the authority does not bear the sword in vain! It is the servant of God to execute wrath on the wrongdoer. Therefore one must be subject, not only because of wrath but also because of conscience. For the same reason you also pay taxes, for the authorities are God’s servants, busy with this very thing. Pay to all what is due to them—taxes to whom taxes are due, revenue to whom revenue is due, respect to whom respect is due, honour to whom honour is due.”

(2) Titus 3:1:
“Remind them (viz., believing Christians) to be subject to the rulers and authorities, to be obedient, to be ready for every good work …”

(3) 1 Peter, 2.13–15, 17:
“For the sake of the Lord, submit to every human institution, whether to the emperor as the supreme authority, or to the governors sent by the emperor to punish evildoers and to praise those doing good … Honour the emperor.”

In essence, these admonitions to Christians are:

(1) Christians should be subject to their respective governments;

(2) These governments have in fact have been brought about by God’s will: “for there is no authority except from God, and those authorities that exist have been instituted by God.”

(3) Christians should pay taxes.

Christians think that St Paul had direct visions and revelations from God and Jesus (e.g., 2 Corinthians 12.1–10), so that for the conservative Christian the passage in Romans must count as orders from god.

For the conservative Christian, then, virtually all extreme forms of libertarianism seem to be ruled out. For example, the extreme Rothbardian might claim that the state is evil, but how can something be evil if it is ultimately instituted by god and he commands you to submit to it?

Of course, the idea that one should submit to government just because the Bible says so is a terrible – and in many ways a horrific – argument, e.g., does this mean that victims of the Nazis in Germany were required to submit to Nazi government? Was the Nazi government actually brought about by God’s will? What about the Soviet Union?

But such moral paradoxes present no problem for the secular person who rejects all forms of religion and belief in god (I happen to be such a person).

They do present the believing Christian with the ethical problems.

Paradoxically, for liberal libertarian Christians of course, the passages above are not a problem. They can claim to be Christians without thinking that all of the Bible is divinely inspired or the literal word of god.

But that then raises the question of what moral theory do Christians really support?

The most crude answer is divine command theory. But that theory faces difficulties so severe that it quickly falls apart. Indeed, historically divine command theory had little support from Christian philosophers.

In short, the problem with divine command theory is this: is something good solely because god orders it, or because it is good by some other objective criteria?

If one really thinks that, say, any action is good simply, solely and only because god has ordered it, this means that morality is ultimately nothing but the arbitrary whim of good. Morality has no objective basis and could in theory be subjectively determined by god.

For example, if god orders mass murder, as he supposedly does in Deuteronomy 2:33–36 and 3:1–11, then mass murder is moral, because god has ordered it. There are Christian philosophers who have seriously taken that position: William of Ockham argued that, yes, anything god orders, even if it appears to be evil, it is actually good and morally obligatory. That is an appalling conclusion, which concedes that we have (in theory) no ultimate moral standard except the subjective whims of god.

If the Christian concedes that an action is good, not because god has ordered it, but because it is good for some independent objective standard or objective criteria, one has conceded that god is not omnipotent (in the conventional sense of that word), for it follows logically that god’s actions and orders are severely limited by some external objective moral principles or standard. Morality ultimately cannot come from god.

There are sly tricks to get around the dilemma. One is to argue that, well, god is inherently good, or god and goodness are identical, so that he, as an omnibenevolent being, can never in actuality do or order anything evil.

But that does not solve the dilemma, for logically this concedes that there could be no god and yet it would in theory be possible for a universe to have objective moral principles or an objective moral standard to guide right action. If one wants to argue that a perfectly good being exists (like an imaginary god), you have not answered the question: what is the standard for perfect goodness anyway? That standard is logically independent of the notion of an omnipotent and omniscient divine being.

All that has occurred is that we are taken right back to the question: if an act is not good merely because god orders it, then there must be some other standard for determining its rightness or wrongness.

The solution most Christian philosophers found is to reject divine command theory and simply take over and develop the pagan Greek and Roman ethical theory of natural law (which goes back to Plato and the ancient Stoics). But natural law theory has difficulties almost as bad as divine command theory. It requires the belief in a “divine order” in the universe and a divinely-created human nature that makes us conform to “natural law.” In other words, it just begs the question by assuming the existence of some divine agency and order in the universe.

Furthermore, the very idea of a “divine order” just raises the question of what standard of morality determines it, and once rationalist European philosophers like Grotius tried to defend natural law theory by removing God and the previous supernatural justification for it, they simply destroyed the only convincing explanation for belief in natural law (Tawney 1998: xxv-xxvi).

Other solutions were like that of Kant: Kantian ethics was in fact partly an attempt to create an objectivist ethics that could defend Christian morality, but by basing morality on moral principles derived from human reason, not from god per se.

So ultimately the most sophisticated Christian philosophers accept that morality does not come from the Bible or directly from god, but that it can be determined by human reason.

Addendum
Although I am completely secular and do not believe in god, I suppose that liberal (non-fundamentalist) Christians could solve their moral conundrum.

Perhaps they might argue as follows.

If one is a sincere liberal Christian, then one might argue that, after all, morality can be independent of god in the sense that it is rationally possible for a moral system to exist even if (hypothetically) god did not.

That is to say, for a perfectly moral being to exist like god, he must follow a moral code that is not just subjective, but objective. Therefore there must be an independent, objective standard of morality. And god must obey it. So god is not really omnipotent in the crude sense of that term: his action is limited by the need to be logically consistent.

But what is the moral code? One solution is deontological ethics (like the system of Kant) and other choice is teleological/consequentialist ethics.

That is, one moral code might be some form of consequentalism. Mill once argued (perhaps insincerely) that god was a utilitarian. But some Christian philosophers do seriously argue that a god would be the perfect consequentialist: he could foresee all consequences of all hypothetical actions into the unbound future, and determine the morally right actions, suggesting these actions by general moral principles, although human beings can only ever have an imperfect grasp of what is perfectly right, because of lack of knowledge and the extreme difficulty of predicting the future.

BIBLIOGRAPHY

Tawney, R. H. 1998. Religion and the Rise of Capitalism. Transaction, New Brunswick, N.J. and London.

Tuesday, March 26, 2013

Ethics is never far from the surface of discussions of economics, especially practical economic polices. Adam Smith, for example, was also an ethical theorist. We also have the spectacle of the Austrian Murray Rothbard who tried to defend and justify his anarcho-capitalist system mainly on natural-rights ethical grounds.

The limitations of early versions of hedonistic utilitarianism are well known, of course: the difficulty of reliably comparing interpersonal utility, and so on.

But hedonistic “act utilitarianism” is only one version of a myriad of ethical theories that can all be subsumed in the broader category of consequentialism.

And consequentialism as a broad group of theories can itself be categorised as one of the two species of teleological ethics, as follows:

There is in fact a high degree of compatibility between a number of modern consequentialist theories.

While I don’t directly endorse any one particular theory above, I suspect that a workable version of consequentialism would require concern for a number of ends, and would draw on various of these theories.

As I think of ethics more and more, I am starting to see some merit in certain aspects of Virtue ethics and Rawl’s rights-based ethics.

Morality must be concerned not just with happiness, but clearly with fairness, justice and justifiable human rights as well.

But my position is in no sense an endorsement of any natural rights theory of ethics, a theory which, I think, remains nonsense. Rights are not natural; they are ethical constructs, requiring rational justification, and requiring human institutions and human beings to enforce them.

(3) it must explain how it overcomes or is consistent with Hume’s “is–ought” problem (sometimes called Hume’s Law and Hume's Guillotine).

A complete answer to the question whether the “good” is really identifiable with natural properties (as naturalism contends), or is an indefinable, non-natural property (as G. E. Moore argued in Principia Ethica) I leave as an open question for further thought, although I do now lean towards the view that the “good” is at least explicable for humans in naturalistic terms.

According to Moore, all naturalist ethical theories commit the “naturalistic fallacy,” though there is some dispute on what exactly Moore meant by this. The “naturalistic fallacy” is not simply a crude fallacy called the “appeal to nature,” which is the assertion that what is natural is therefore inherently moral. Nor would some philosophers say that the “naturalistic fallacy” is the same as Hume’s “is–ought” problem.

Moore’s “naturalistic fallacy” consists in the (alleged) fallacy of identifying the property of goodness with some other natural property or thing.

For example, one could say:

(1) Pleasure is good.

This is a proposition, but it has two possible meanings, as follows:

(1) Pleasure is a thing that has the independent property of being good.(2) Pleasure is identical with the concept “good.” That is, they are one and same thing.

In order to understand what Moore means, we must understand the somewhat confusing grammatical differences in the way the word “is” is used in English.

The verb “is” has 3 possible grammatical uses in English:

(1) to covey identity, e.g., “He is John” (They are one and same thing);(2) predication (as the so-called copula or linking verb), e.g., “This desk is white” (that is, this desk has the property of being “white,” but obviously the “desk” per se is simply not the same thing as “white”);(3) existence or being, e.g., “There is a high mountain two miles from here” (that is, there exists a mountain that is two miles from this location).

Just because we can use the word “good” with “is” in sense (2), Moore says, it does not follow that anything supposedly having the property goodness can be identified with the “good” in sense (1) (that is, identity). To assert that anything natural x is actually identical with the “good” in sense (1) is the “naturalistic fallacy.” Moore therefore contends that the “good” is an ineffable and non-natural property.

Whatever one thinks here, it is still possible in principle to be a moral consequentialist and to accept Moore’s non-naturalist views on the nature of the “good” (Levine 2002: 136), and then proceed to construct a consequentialist ethics. Moore himself did so, and was a moral consequentialist.

As to Hume’s “is–ought” problem, this seems rather more difficult. Now many philosophers contend that it is very easy to derive an “ought” from an “is” in a non-moral sense. For example, a working clock keeps time, so logically a clock ought to keep time in a sense that is non-ethical, that is, merely teleological. But that does not really help the moral theorist.

For example, one can observe the empirical (descriptive) fact that leaves naturally fall under the influence of gravity to the ground. Does it follow from this in a clear logical way that a leaf has a moral right to fall to the ground? No, it does not. My stopping the leaf falling to the ground does not appear to be immoral in a way logically derivable from the descriptive fact. Just because the nature of a leaf is to fall to the ground under the influence of gravity, it does not follow that the leaf has any moral right whatsoever to fall to the ground.

You can complain that morality should only involve sentient beings. But the difficulty is still apparent. If a person takes possession of unoccupied property never claimed by anyone else, this can also be expressed as a descriptive fact. But does it follow from the descriptive fact that such a person now has a moral right to absolute ownership and use of his homesteaded property? Is the moral statement “John ought to have the right of absolute ownership and use of his homesteaded property” a proposition that is true and justified (a moral fact) derivable from the previous mere descriptive fact? It does not logically follow.

If we say that “theft is the cause of serious problems in human society,” how is the moral injunction that follows, that “you ought not to steal,” a morally justified, true ethical fact? How do you derive that “ought” from the “is”?

If one wants to argue that all moral injunctions are really teleological imperatives to achieve some aim or end, then I suppose one has solved Hume’s “is–ought” problem, and endorsed some form of non-cognitivism, the view that there are in fact no “moral facts” as such and no “moral knowledge.” One version of non-cognitivism is the prescriptivism of R. M. Hare: what we think are ethical statements are just imperative statements. “You ought not to steal” becomes “do not steal!” but in a sense that is not a moral fact, but an imperative. Strictly speaking, the prescriptivist argues that any moral judgement is not a descriptive statement and is never entailed by any other descriptive fact.

That is, if one wants to admit that a moral “ought” statement does not really possess the property of truth or falsity, and in fact is never true or false, and can only be obeyed or disobeyed (since it only urges a course of action as an imperative does), then one has evaded Hume’s “is–ought” problem (though the prescriptivist, however, asserts that one can still reason about moral imperatives, not just about descriptive facts).

But many might complain that this a high price to pay for having solved (or perhaps evaded) Hume’s “is–ought” problem.

Other moral naturalists contend that one can derive the moral “ought” from “is,” and see the answer in the nature and logic of goal-directed behavior. I am not sure they have really solved the problem, and at best one should subject all claims to deriving a moral prescription from some descriptive fact to careful scrutiny.

Perhaps the solution really is to say that assumed moral injunctions are imperatives. Whatever justification is given consists in asserting that actions are urged to achieve certain ends to allow human society to function in a way that is conducive to order, known rules, predictability in life and social harmony. A direct moral injunction does not constitute a true moral statement at all, but is an imperative to urge action in a teleological sense to make society work.

That is the basic utilitarian function of what we call morality, and once one has proposed ends or aims, one can

(1) defend them by showing how other moral theories are flawed and unjustifiable;

(2) defend one’s proposed ends or aims in discourse to see how far one can obtain agreement from other human beings, and

(3) logically and empirically examine how to achieve the teleological ends: that is to say, what consequences follow about what should be done and should not be done to achieve the stated aims.

Returning to the main argument, crude versions of utilitarianism focusing merely on happiness/pleasure/utility as the sole good are inadequate, but not more sophisticated forms of consequentialism that argue that multiple moral aims (or consequences) are what must be aimed at.

I would propose a version of consequentialism that holds we should aim at more ends than just utility/happiness such as the following:

(1) preservation of human life where the people in question wish to continue to live and we can clearly ascertain this* (e.g., the man dying of disease in a highly privatised system of health care, the starving human being who is unemployed and who finds no private charity). Such an end has precedents in 20th century forms of consequentialism.

(2) minimising suffering, especially where this can be done with redistribution of resources that are relatively abundant (on this point, I wish to take Karl Popper’s negative consequentialism and make it part of a larger consequentialist system).

(3) aiming at the end of respecting certain individual rights where not doing so would harm the functioning of society significantly or would violate the sense of justice or fairness that an individual must feel to have respect for the law and confidence in others, in so far as this does not lead to gross violations of (1) or (2) (on this, I think notions of justice and fairness are legitimate ends, as in Rawls’s critiques of some crude utilitarian theories).

* Although this is quite compatible with the idea of voluntary euthanasia when expressed clearly by those of sound mind suffering from painful terminal disease, I will leave this question open.

These additions to consequentialist ends aimed at overcome most of the traditional objections to utilitarianism.

I suspect the alleged incompatibility of consequentialism with other theories is exaggerated.

This is an ethics that strongly supports the right to be free from unjustifiable coercion, unjustifiable suffering, arbitrary killing, and theft (non-justifiable appropriation of external property), but at the same time the limited right to control over external property.

But also one’s right not to die simply because one cannot find a job in a laissez faire society or successfully beg for private charity; and the right not to live in poverty or without adequate health care, and so on.

Addendum
Here is a puzzle for grammarians and philosophers.

What is the grammatical status of this sentence?:

“When playing a normal* game of chess, one ought to play to win the game.”

* Normal in the sense of not playing to deliberately lose or draw.

I suppose the obvious answer is that it is a sentence in the subjunctive mood.

Some might complain that the grammatical form of the sentence is misleading. Perhaps it is really just an imperative: “Play a normal game of chess to win!”

But can it be understood as a true proposition? That is, it is simply a true statement that a person playing a normal game of chess plays to win in a teleological sense. This is the purpose of chess.

Can a subjunctive even be true or false?

In addition, it is clearly not an ethical proposition. If you do not play a normal game of chess to win, then you are not immoral or evil, but simply acting contrary to the convention of behaviour required by the game.

Sunday, March 24, 2013

“The market economy must be strictly differentiated from the second thinkable—although not realizable—system of social cooperation under the division of labor: the system of social or governmental ownership of the means of production. This second system is commonly called socialism, communism, planned economy, or state capitalism. The market economy or capitalism, as it is usually called, and the socialist economy preclude one another. There is no mixture of the two systems possible or thinkable; there is no such thing as a mixed economy, a system that would be in part capitalistic and in part socialist. Production is directed by the market or by the decrees of a production tsar or a committee of production tsars.

If within a society based on private ownership by the means of production some of these means are publicly owned and operated—that is, owned and operated by the government or one of its agencies—this does not make for a mixed system which would combine socialism and capitalism. The fact that the state or municipalities own and operate some plants does not alter the characteristic features of the market economy. These publicly owned and operated enterprises are subject to the sovereignty of the market. They must fit themselves, as buyers of raw materials, equipment, and labor, and as sellers of goods and services, into the scheme of the market economy. They are subject to the laws of the market and thereby depend on the consumers who may or may not patronize them. They must strive for profits or, at least, to avoid losses. The government may cover losses of its plants or shops by drawing on public funds. But this neither eliminates nor mitigates the supremacy of the market; it merely shifts it to another sector. For the means for covering the losses must be raised by the imposition of taxes. But this taxation has its effects on the market and influences the economic structure according to the laws of the market. It is the operation of the market, and not the government collecting the taxes, that decides upon whom the incidence of the taxes falls and how they affect production and consumption. Thus the market, not a government bureau, determines the working of these publicly operated enterprises.

Nothing that is in any way connected with the operation of a market is in the praxeological or economic sense to be called socialism. The notion of socialism as conceived and defined by all socialists implies the absence of a market for factors of production and of prices of such factors.” (Mises 1998: 259-260).

Did you get that? There is no such thing as a mixed economy. I do not find this convincing, but its logical implications are interesting.

According to Mises, a market economy even with some degree of government owned and operated industry still does not make an economy “socialist.” What makes an economy “socialist” is the “absence of a market for factors of production and of prices of such factors.”

So what on earth were the mixed economies of the golden age of capitalism (1945 to 1973) with their Keynesian fiscal policies, financial regulation, and central banks? Mises published the first edition of Human Action in 1949 when he observed all around him the reality of Western mixed economies with nationalised industries and Keynesian fiscal policies. He must have looked in horror as this system produced unprecedented economic growth, low unemployment and economic stability. Was this his justification of why the system he saw around him was working and prospering?

Curiously, no. He appears to have declared most of the capitalist West “socialist” after 1945!

But the trouble is that Mises is simply astonishingly inconsistent and incoherent on this subject. Having defined “socialism” as an economy without markets “for factors of production and of prices of such factors,” Mises then tells us that Britain and other nations after 1945 were in fact socialist but for different reasons:

“Marching ever further on the way of interventionism, first Germany, then Great Britain and many other European countries have adopted central planning, the Hindenburg pattern of socialism. It is noteworthy that in Germany the deciding measures were not resorted to by the Nazis, but some time before Hitler seized power by Bruning, the Catholic Chancellor of the Weimar Republic, and in Great Britain not by the Labor Party but by the Tory Prime Minister Mr. Churchill. The fact has been purposely obscured by the great sensation made in Great Britain about the nationalization of the Bank of England, the coal mines, and other enterprises. However, these seizures were of subordinate importance only. Great Britain is to be called a socialist country not because certain enterprises have been formally expropriated and nationalized, but because all the economic activities of all citizens are subject to full control by the government and its agencies. The authorities direct the allocation of capital and of manpower to the various branches of business; they determine what should be produced and in what quality and quantity, and they assign to each consumer a definite ration. Supremacy in all economic matters is exclusively vested in the government. The people are reduced to the status of wards. To the businessmen, the former entrepreneurs, merely quasi-managerial functions are left. All that they are free to do is to carry into effect the entrepreneurial decisions of the authorities within a neatly delimited narrow field.” (Mises 1998: 855).

Something stinks in Human Action: it is basic standards of argument, consistency and factual accuracy.

First, factual accuracy. According to Mises, the UK after 1945 was a “socialist country,” because the government (allegedly) planned all investment and consumption! Now, while it is true that the UK even after 1945 did (for example) have rationing for some years, the idea that Britain was a total planned economy is so bizarrely factually incorrect that it boggles the mind.

In the UK, the reality is that rationing for clothing and furniture was abolished in 1948 (before Human Action was published), and all other limited rationing by 1954. There was indeed some nationalisation of certain industries in the UK after 1945 (the “commanding heights”), but we have already seen above that Mises specifically denies that some limited nationalised industries can make a country socialist. Nor did the use of Keynesian fiscal policy involve planning of production or consumption. And most capital goods in the UK were privately owned, most production was private and conducted for profit, and to satisfy consumer preferences. Mises was utterly ignorant or delusional when he declared that in Britain “all the economic activities of all citizens are subject to full control by the government and its agencies.”

Second, let us turn to consistency of argument. The UK without any doubt had money prices and markets for factor inputs after 1945, so according to Mises’s fundamental criterion expressed above in the first passage from Human Action the UK cannot have been a socialist country.

Yet mysteriously Mises declares that it was a “socialist country,” blatantly contradicting himself. The whole inconsistency is made much worse by the strident statement in Human Action (on the page after my last quotation) that most of the post-1945 Western European countries were now also socialist too! (Mises 1998: 856). Yet there is no doubt that these nations (like the UK) also had money prices for factors of production. So how can they have been socialist? We have an astonishing contradiction here.

Moreover, if Western European nations really were socialist and lacked economic calculation, then a central element of Mises’s whole economic theory comes crashing down. Why didn’t the UK or “socialist” Western Europe collapse into chaos after 1945 if they were incapable of rational economic calculation?

Well, Mises does have an answer. We suddenly read in Human Action (Mises 1998: 856) that in fact Western Europe was still able to calculate, and these economies were still based on economic calculation — despite the fact that Mises declares them “socialist” and his definition of “socialism” is an economy that lacks economic calculation. The main reason (according to Mises) was that the market economy of the United States allowed Western Europe to engage in economic calculation, even though in reality (though it never filtered through to Mises’s brain) the economy of the United States was subject to almost the same degree of government intervention (apart from nationalised industry, which, as we have already seen, is irrelevant anyhow) as any Western European nation!

Finally, let us be charitable and assume that Mises was thinking of the UK during WWII when he wrote the passage above. In WWII, there was indeed a moderate command economy in Britain (as in the US, Canada, Australia and New Zealand) where a considerable amount of (mainly military) production was planned by the government. But even during the war money prices and markets for factor inputs still existed, so the UK cannot have been a socialist country even in these years. So, by Mises’s own logic, even Western wartime command economies cannot really have been “socialist” systems at all — even though those command economies really were the only real historical instance when the Western economies was run rather like planned, communist systems.

Just reading Human Action on these issues, it is astonishing to me that anyone can ever declare that Mises was the greatest economist who ever lived (as some Austrians actually do). On this subject, Mises was an ignorant and muddle-headed idiot, and it is not surprising that after 1945 he was ignored by serious economists.

I can just imagine economists reading these passages of Human Action and then throwing the book in the dustbin as they moved on to more important matters.

It is sometimes claimed that the Keynesian golden age of capitalism (1946 to 1973) had an accelerating inflation rate. The story goes: all Keynesianism did was cause a never-ending, upward trend in inflation rates.

The myth was peddled by (of all people!) the British Labour politician James Callaghan (UK Prime Minister from 1976 to 1979) when in 1976 he declared that Keynesianism “only worked on each occasion ... by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step,” before he introduced at least a rhetorical commitment to a pre-Thatcherite form of monetarism in the UK.

But it is nonsense, certainly in the case of the US, as we can see in the graph below.

There were two outliers: the post-WWII inflation and the Korean War inflation. But, apart from these, the inflationary spike that did break out after 1968 was unusual and a deviation from the basic price stability of the golden age. That price stability was most notable for the late 1950s and most of the 1960s. In fact, actual deflation briefly occurred twice in the post-WWII era.

As Nicholas Kaldor long ago noted, during the golden age “for a long time the rate of inflation (as measured by consumer prices) remained moderate, and until the closing years of the 1960s it showed no clear tendency to acceleration” (Kaldor 1976: 214).

The reason for the inflationary crisis of the 1970s was four-fold:

(1) From 1968–1971 there were the beginnings of inflationary pressures, in both wages and prices in many industrialised nations. The fundamental cause was that around 1968–1969 in Japan, France, Belgium and the Netherlands and from 1969–1970 in Germany, Italy, Switzerland and the UK wage rises had occurred, which Kaldor attributes to strong action by unions (Kaldor 1976: 224). There is a perpetual struggle between capitalists and labour over distribution of income, and it just happened that around 1968 to 1970 labour won out in many countries causing a bout of cost-push inflation (via wage increases). But this would not have become a serious problem had it not been for factors (2), (3), and (4).

(2) the dismantling of commodity buffer stock policies that had previously ensured price stability. The prelude to stagflation was marked by a significant explosion in commodity prices that occurred in the second half of 1972. Part of the problem was the failure of the harvest in the old Soviet Union in 1972–1973 and the unexpectedly large purchases on world markets by the Soviet state. This could have been averted had the United States not dismantled its commodity buffer stock policies in the 1960s.

(3) The end of Bretton Woods (the post-WWII international monetary system) was momentous: inflationary expectations and instability on financial and commodity markets resulted, as well as a rise in commodity speculation as a hedge against inflation. This contributed to the cost-push inflation that was being felt in many countries after 1971.

(4) The final factor that caused the severe inflation of the 1970s was the first oil shock from October 1973, when various Middle Eastern producers of oil instituted an embargo that lasted until March 1974 (Kaldor 1976: 226). In most countries, the double digit inflation of the 1970s was caused by the oil shocks (both the first and second).

The unfortunate concatenation of these historically unprecedented shocks – that is, factors (1), (2), (3), and (4) – in toto was the cause of 1970s stagflation.

Kaldor stresses the importance of factor (2). During most of the golden age of capitalism (1945–1973), primary commodity buffer stocks had created stable prices. But this policy was changed in the 1960s when the US modified its buffer stock policies:

“… the duration and stability of the post-war economic boom owed a great deal to the policies of the United States and other governments in absorbing and carrying stocks of grain and other basic commodities both for price stabilisation and for strategic purposes. Many people are also convinced that if the United States had shown greater readiness to carry stocks of grain (instead of trying by all means throughout the 1960s to eliminate its huge surpluses by giving away wheat under PL 480 provisions and by reducing output through acreage restriction) the sharp rise of food prices following upon the large grain purchases by the U.S.S.R. [in 1972–1973], which unhinged the stability of the world price level far more than anything else, could have been avoided.” (Kaldor 1976: 228).

That was a major factor causing stagflation, along with wage–price spirals. The first oil shock was a final factor that exacerbated everything.

Saturday, March 23, 2013

“prices that are generated by the market process and serve as the data for economic calculation. These are realized prices; or, in other words, they are the actual outcome of the historical market process at each moment in time and are determined by the value scales of the marginal pairs in each market. They are, therefore, also market-clearing prices the establishment of which coincides with a momentary situation, what Mises calls the ‘plain state of rest’ (PSR), in which no market participant, given his existing marginal-utility rankings of goods and money and knowledge of prevailing prices, can enhance his welfare by participating in further exchange. However, despite their character as market-clearing prices, these are also disequilibrium prices. Thus as a consequence of the unavoidable errors of entrepreneurial forecasting and price appraisement under uncertainty, most goods are sold at prices that do not conform to their monetary costs of production, thereby generating realized profits and losses for producers.” (Salerno 1990: 121).

So prices are “disequilibrium prices” in the sense that they are not equal to costs of production, but allow profit and loss. Nevertheless, supply and demand are equated by a tendency to market-clearing prices:

“Mises conceives the market process as coordinative, ‘the essence of coordination of all elements of supply and demand.’ This means that the structure of realized (disequilibrium) prices, which continually emerges in the course of the market process and whose elements are employed for monetary calculation, performs the indispensable function of clearing all markets and, in the process, coordinating the productive employments and combinations of all resources with one another and with the anticipated preferences of consumers.” (Salerno 1993: 124).

Present prices or prices of the immediate past (or “realised prices” in Mises’s terminology) are the basis for monetary calculation when entrepreneurs guess or forecast prices in an uncertain future (Salerno 1993: 123).

But the market process is open-ended, because continuous change always shifts the end point equilibrium state which Mises calls “final state of rest” and into a new state, then a new state and so on.

Therefore economies do not have a long-term tendency to equilibrium (Salerno 1993: 122), but rather at most shifting, very short term tendencies, which are always thwarted.

But the Misesian theory is not the same as that of Hayek.

For example,

“The Hayekian paradigm stresses the fragmentation of knowledge and its dispersion among the multitude of individual consumers and producers as the primary problem of social and economic cooperation and views the market’s price system as the means by which such dispersed knowledge is ferreted out and communicated to the relevant decision-makers in the production process.” (Salerno 1993: 115).

In contrast to this,

“Salerno points out that for Mises, knowledge and appraisal on the market are complementary, and have very different natures and functions. Knowledge is an individual process, by which each individual entrepreneur learns as much as he can about the largely qualitative nature of the market he faces, the values, products, techniques, demands, configurations of the market, and so on. This process necessarily goes on only in the minds of each individual. On the other hand, the prices provided by the market, especially the prices of means of production, are a social process, available to all participants, by which the entrepreneur is able to appraise and estimate future costs and prices. In the market economy, qualitative knowledge can be transmuted, by the free price system, into rational economic calculation of quantitative prices and costs, thus enabling entrepreneurial action on the market.

As Salerno notes: ‘competition therefore acquires the characteristic of a quintessentially social process, not because its operation presupposes knowledge discovery [as with Hayek-Kirzner], which is inescapably an individual function, but because, in the absence of competitively determined money prices for the factors of production, possession of literally all the knowledge in the world would not enable an individual to allocate productive resources, economically within the social division of labor.’

In short, the entire Hayekian emphasis on ignorance and ‘knowledge’ is misplaced and misconceived.” (Rothbard 1992: 19–21).

Friday, March 22, 2013

If you are not interested in the fratricidal minutiae of Austrian economics, skip this post!

In the late 20th century, Austrian economics was troubled by a controversy between Misesians and Hayekians.

On the one hand, Misesians like Joseph T. Salerno (1990, 1991, 1993, and 1994) and Murray Rothbard (1991, 1992, and 1994; see also Herbener 1991) charged Hayek and his followers (like Israel M. Kirzner) with deviating from the “pure” Misesian orthodoxy on the nature of coordination in market systems.

Two of major antagonists – Rothbard and Kirzner – were both students of Mises.

In short, the Misesians charged that there was serious chasm between Mises’s and Hayek’s understanding of markets. It is a surprisingly interesting debate, and elucidates some important points about modern Austrian economics.

First, the nasty nature of the debate drove an exasperated Israel M. Kirzner to this astonishing statement:

“The biting sarcasm employed in this assertion is but a relatively mild example of the rhetorical excesses appallingly to be found in the ‘two paradigm’ literature against such writers as Hayek, Lachmann, and others charged with having diverged from the asserted ‘Misesian paradigm.’ I take this opportunity strongly to protest the use of verbal terrorism in Austrian economics. Even if (which is far from being the case) the asserted criticisms of Hayek, Lachmann, and others were valid, there would be absolutely no justification for the manner in which these great economists have been treated in the literature under discussion. The near-demonization of Hayek and Lachmann for alleged deviations from an asserted Misesian orthodoxy is a most distressing phenomenon. If Austrian economists (and the Review of Austrian Economics) are to be able to work constructively in the rough and tumble of the intellectual market place, anything approaching rhetorical brawling must once and for all be rejected.” (Kirzner 2000: 162–163, n. 2).

So on the face of it, this must have been a serious dispute!

What was the dispute about? Let us review it below.

I. Misesian Socialist Economic Calculation versus the Hayekian Knowledge Problem
First, the dispute concerns the differences between Mises’s original “socialist calculation problem” and Hayek’s “knowledge problem.” Kirzner argues that Salerno and Rothbard came to the “unwarranted conclusion … that the Misesian calculation problem has nothing whatever to do with Hayek’s knowledge problem” (Kirzner 2000: 157).

In contrast, Salerno argues that Hayek’s “knowledge problem” is different from Mises’s original “socialist economic calculation problem,” and even Kirzner concedes that Mises did not formulate the “calculation problem” in terms of knowledge (Kirzner 2000: 158).

“It is now universally acknowledged that Ludwig von Mises, allegedly the loser in the famous socialist calculation debate that he launched in 1920, was really right: clearly, socialism cannot calculate, it cannot run a complex modern economic system. But it has only recently become clear, through the insights of Professor Salerno, precisely why Mises was right, and also how the Misesian message was systematically distorted, from the 1930s until recent years, by F.A. Hayek and his followers. For Hayek and the Hayekians, obsessed with the alleged ‘problem of knowledge,’ have systematically misinterpreted Mises as maintaining solely that the Socialist Planning Board, facing the uncertainty of a dynamic economy, lacks the knowledge enabling it to plan the production and allocate the resources of a socialist economy. In contrast, the market economy, through its price signals, conveys that needed knowledge from and to the various participants in the market economy.

Mises, while not disputing the importance of knowledge and its dissemination through the price system, was, however, arguing a totally different point. From 1920 on, he reasoned as follows: assume the best for the Social Planning Board. Assume that, by some magical process, it has been able to discover and know absolutely all the value-scales of consumers, all technological methods, and compile an inventory of all resources. Suppose, then, Mises says, we grant total knowledge of all these data to the Socialist Planning Board. It still will not be able to calculate, still will not be able to figure out costs and prices, particularly of land and capital goods, and therefore will not be able to allocate resources rationally. The real problem of the Planning Board, then, the major thing denied that Board by absence of a market, is not knowledge but economic calculation.

Thus, to Hayek, if the Planning Board could by some magic know, as people come to know through the market, consumer values, technologies, and resources, it could rationally plan and allocate resources fully as well as the market. As usual for Hayek and the Hayekians, the argument for the free market and against statism rests only on an argument from ignorance. But to Mises, the problem for the Planning Board is not knowledge but calculability. As Salerno puts it, the knowledge conveyed by present (or ‘immediate past’) prices rests on values, techniques, and resources of the immediate past. But what acting man is interested in, especially the entrepreneur in committing resources into production and future sale, is future prices and future costs. The entrepreneur, who commits present resources, does so because he appraises—anticipates and estimates future prices—and allocates resources accordingly. It is, then, the appraising entrepreneur, driven by his quest for profits and for avoidance of losses, who can calculate and appraise because a genuine price system exists in the means of production, in land and capital goods, that is, a system of exchanges of privately-owned capital resources. Only such a pricing system allows for calculation.

Salerno points out that for Mises, knowledge and appraisal on the market are complementary, and have very different natures and functions. Knowledge is an individual process, by which each individual entrepreneur learns as much as he can about the largely qualitative nature of the market he faces, the values, products, techniques, demands, configurations of the market, and so on. This process necessarily goes on only in the minds of each individual. On the other hand, the prices provided by the market, especially the prices of means of production, are a social process, available to all participants, by which the entrepreneur is able to appraise and estimate future costs and prices. In the market economy, qualitative knowledge can be transmuted, by the free price system, into rational economic calculation of quantitative prices and costs, thus enabling entrepreneurial action on the market.

As Salerno notes: ‘competition therefore acquires the characteristic of a quintessentially social process, not because its operation presupposes knowledge discovery [as with Hayek-Kirzner], which is inescapably an individual function, but because, in the absence of competitively determined money prices for the factors of production, possession of literally all the knowledge in the world would not enable an individual to allocate productive resources, economically within the social division of labor.’

In short, the entire Hayekian emphasis on ignorance and ‘knowledge’ is misplaced and misconceived.” (Rothbard 1992: 19–21).

The difference between Mises’s and Hayek’s idea on the price system is summarised by Salerno:

“The price system is not—and praxeologically cannot be—a mechanism for economizing and communicating the knowledge relevant to production plans. [which is position of Hayek – LK] The realized prices of history are an accessory of appraisement, the mental operation in which the faculty of understanding is used to assess the quantitative structure of price relationships which corresponds to an anticipated constellation of the economic data. Nor are anticipated future prices tools of knowledge; they are instruments of economic calculation. And economic calculation itself is not the means of acquiring knowledge, but the very prerequisite of rational action within the setting of the social division of labor. It provides individuals, whatever their endowment of knowledge, the indispensable tool for attaining a mental grasp and comparison of the means and ends of social action.” (Salerno 1990: 44).

“There is a significant implication of our interpretation of Mises’s critique of socialism. Although the market economy has perfectly solved the problem of economic calculation—its very existence attests to the veracity of this conclusion—praxeologically, at least, it is on all fours with socialism with regard to the knowledge problem. For the imperfection of knowledge deriving from uncertainty of the future is a category of all human action, which cannot be overcome by recourse to the market price system, entrepreneurial alertness, the competitive discovery process, and so on.” (Salerno 1990: 48).

So according to the Misesians both a market economy and a socialist planned economy are subject to the “knowledge problem.”

According to the Misesians, the primary reason why a socialist, planned economy cannot work is (allegedly) that it lacks money prices for factors of production.

II. Hayekian Prices as Signals that Solve the “Knowledge Problem”
Secondly, we have the role of prices as signals for communicating knowledge in Hayek’s thought.

Salerno argues that Kirzner’s entrepreneurial discovery process is derived from Hayek’s view of prices as communicating knowledge to ignorant market participants so that their ex ante plans for production and consumption are coordinated (Salerno 1993: 126), even though Kirzner himself recognises that exogenous change thwarts such a long-run equilibrating tendency and that the market is “never in or near a state of equilibrium” (Salerno 1993: 128).

But Hayek apparently held a different view. Even when Hayek abandoned his belief in the real existence of an equilibrium state and the belief in strict ex ante plan coordination, he still required a real world condition of close correspondence or proximity to such a state (Salerno 1993: 127–128).

Salerno contends that:

“as Hayek points out, in order for prices to fulfill their knowledge-disseminating and plan-coordinating functions, the economy must subsist in a state of what I will call ‘proximal equilibrium,’ wherein realized prices are always fairly accurate indicators of future prices.” (Salerno 1993: 128).

Thus, in Hayek’s view, there is a real-world tendency for “market prices to conform to their equilibrium levels” (Salerno 1993: 128).

Rothbard points to the distinction between Mises’s concept of equilibrium and that of Hayek:

“The Misesian concept of equilibrium is as a remote goal, toward which economic processes are tending, but which they would only reach if divine intervention froze for many years all the relevant data of the economy: values, knowledge, technology, resources, expectations. But for Hayek ever since the 1920s (and for Kirzner following him), general equilibrium, while not actually extant, is right around the corner: in what Salerno calls ‘near equilibrium.’ It is only in near, or virtual, equilibrium, whether that of Hayek, Kirzner, or Schumpeter, that entrepreneurial creativity would be at all disruptive or disequilibrating; in a Misesian market economy, on the other hand, creativity would simply and smoothly change the remote equilibrium toward which the economy will be tending.” (Rothbard 1994: 560).

In a world where the economy is in a state close to equilibrium and prices are normally near their long-run equilibrium values, expectations become “a trivial byproduct of the knowledge culled from past prices” (Salerno 2010: 232). That is to say, Hayekian theory has an utterly unrealistic view of the economy and of expectations. And this is according to Misesians, not non-Austrian critics of Hayek.

On the other side, Kirzner agreed that, for “Mises (as Salerno and Rothbard correctly point out) prices are not primarily signals economizing on the cost of communicating information” (Kirzner 2000: 159), but nevertheless Kirzner maintained the fundamental compatibility of Mises’s and Hayek’s viewpoints.

III. Conclusions

So what are the conclusions from all this? They are as follows:

(1) Austrians are deeply divided on the significance and even truth of Hayek’s “knowledge problem”;

(2) the Austrians cannot get their story straight on what it is that makes rational economic calculation in a planned economy impossible;

(3) there is some merit to the Misesian critique of Hayek, in that the Hayekian idea of an economy normally in “near equilibrium” or “proximal equilibrium” is wholly unrealistic and the role of prices in Hayek’s thought is erroneous.

But the Misesians, even with their criticism, have no better theory.

Both Misesians and Hayekians live in a fantasy world, with respect to the price system. Both are dependent on the notion of universally flexible prices created by the dynamics of supply and demand curves, tending towards their market-clearing values. Both have failed to grasp the widespread reality and significance of fixprice markets and price administration. The real-world and widespread existence of fixprice markets “necessarily means that administered prices are not market-clearing prices and nor do they vary with each change in sales (or shift in the virtually non-existent market or enterprises ‘demand curve’)” (Lee 1994: 320, n. 18). Hence there is no reason why a market economy in general (outside of its flexprice markets) tends to equate supply with demand by means of flexible prices, and “in actual adjustment of supply and demand, prices play only a very subordinate role, if any [sc. role]” (Kaldor 1985: 25; my emphasis).

Hayek’s “knowledge problem” and his attempted solution are mostly a pseudo-problem and pseudo-answer, because Hayek was assuming a world in “proximal equilibrium,” without genuine uncertainty and without a proper role for diverging and subjective expectations.

To the extent that markets have coordination (as opposed to fictitious tendencies to long-run equilibrium states), they do so largely by “quantity signals,” that is, demand, sales volume, and signals from changes in inventories/stocks.

Moreover, profits are actively created and managed by means of cost of production plus profit markup pricing. The profit markup is often stable, which leads to some degree of stability of profits (Gu and Lee 2012: 461). Stable profits in turn allow stable margins for internal financing of investment (Melmiès 2012). The advantages of price setting to businesses include the reduction of the occurrence of price wars, goodwill relationships with customers, and stable selling costs (Gu and Lee 2012: 461). Empirical studies show that, outside given limits, businesses find that variations in their set prices produce no significant change in sales volume, and, above all, when prices are cut, this does not necessarily lead to changes in short term market sales (Gu and Lee 2012: 462). And experiments with prices adjusted downwards to a significant extent show that this causes a severe blow to profits, so severe indeed that enterprises quickly abandon all such experiments (Gu and Lee 2012: 461).

This is the reality of prices in a capitalist economy.

There is a further criticism of Hayek’s knowledge problem that can be made, according to Michael Emmett Brady.

Brady argues that Hayek’s concept of uncertainty and the role of knowledge are quite distinct from that of fundamental uncertainty as defined by Frank Knight and Keynes:

“Uncertainty for Hayek means that each individual decision maker only has a small piece of the puzzle. However, as a whole, the aggregated set of all decision makers have a complete set of all relevant knowledge. There are no pieces missing, lacking or unavailable from the puzzle. Market prices organize and synthesize the aggregate amount of knowledge so that market price signals, understood only by savvy, knowledgeable entrepreneurs, [eliminate] … any uncertainty.” (p. 14)

“Keynes, Knight and Schumpeter deny Hayek’s claim that the market generates price vectors which concentrate the knowledge so that savvy, knowledgeable entrepreneurs can act on this information and solve the problem of uncertainty. Uncertainty means vital important information is missing. Pieces from the puzzle are missing and will not turn up in the future” (p. 14).

“Hayek could not accept the standard concept of uncertainty as defined by Keynes, Knight and Schumpeter because it would then be impossible for market prices to concentrate knowledge that did not exist. In conclusion, nowhere in any of Hayek’s three articles on Knowledge in Economics in 1937, 1945 and 1947 does Hayek deal with the standard view that uncertainty means knowledge that is not there.” (p. 15).